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New trust for small investors links returns to world’s top hedge funds

by Wayne Cheveldayoff, 2003-11-10

The latest twist in hedge fund investing in Canada is the introduction of index-linked performance.

Instead of having returns dependent on a single manager, or a small group of managers as is the case for fund of fund situations, a new trust being introduced for small investors for the first time links returns to an index that tracks the performance of the top 60 hedge funds in the world.

The move to index performance, coupled with low minimum investments, is likely to bring hedge fund investing more into the mainstream in Canada where investing in stock indices has grown more popular over the past decade.

The new trust was introduced in late October by one of the giants in the hedge fund industry, Tremont Capital Management Inc., a U.S.-based firm that is a global leader in the field of hedge fund investment management and research with US$9 billion under management.

Known as the Tremont Hedge Fund Index Linked Trust (see prospectus at www.sedar.com), the trust is available for a minimum investment of $5,000 and will give investors the performance of the CSFB/Tremont Investable Hedge Fund Index over a seven-year term.

The investable index, a sub index of the widely followed CSFB Tremont Hedge Fund Index, includes the six largest hedge funds in each of 10 different hedge fund categories of the overall index, which tracks 442 managers.

The 10 categories include the usual long/short equity and futures managers as well as managers involved in convertible arbitrage, dedicated short bias, emerging markets, equity market neutral, event driven, fixed income arbitrage, global macro strategies and multi-strategy approaches.

As with stock index investing, one definite advantage for investors is the transparency and ease with which performance can be tracked. The Tremont hedge fund indexes and their components can be viewed for month-to-month performance at www.hedgeindex.com (you need to register to get all the data but its free).

Although the investable index was publicly introduced very recently (August 2003), the prospectus shows a reconstruction of how it would have performed if it had existed since January 2000.

While the Dow Jones Industrial Average (DJIA) fell a cumulative 19.3 per cent from January 1, 2000 to September 30, 2003, the investable hedge fund index would have risen by 37.8 per cent. The annualized rate was minus 5.6 per cent for the DJIA but would have been plus 8.9 per cent for the investable hedge fund index.

The performance underlines what advocates of hedge fund investing have been saying about why it has a place in the diversification of small investors’ portfolios. Hedge fund performance has little correlation to stock market performance and it achieves decent returns with much less risk compared with stocks. The volatility measure for the investable index was 2.7 per cent, versus 17.9 per cent for the DJIA.

While Tremont was first out of the gate with a pure index-linked offering, others have already jumped in with something similar.

Toronto-based ONE Financial announced in early November that it has launched the ONE Financial MSCI Hedge Invest Index Notes, Series 1, which are linked to an index which tracks the performance of 74 established hedge fund managers involved in 11 broad investment processes.

While the Tremont trust units can go up or down like a stock index, the new ONE Financial notes carry a unique double guarantee. The notes (minimum $2,000 investment) are issued by Societe Generale Canada and 100 per cent of the principal and a minimum 10 per cent return are guaranteed by the Paris-based parent Societe Generale, one of the world’s largest banks.

When the notes mature in nine years, investors will receive their principal, plus the greater of a 10 per cent return and up to 150 per cent enhanced participation of a fund linked to a version of the Morgan Stanley Capital International (MSCI) Hedge Invest Index that, based on a pro-forma calculation, would have shown a performance of 15.5 per cent per annum over the past 10 years with one quarter of the volatility of the S&P 500 stock market index.

While the returns look great compared with equity indices over the past three years, good times in any investment category don’t always go on forever. Investors should always know what they are buying and what the risks are.

This takes a lot of research. Since the hedge fund offerings are often complicated and with numerous fees attached, it is best to consult with a knowledgeable investment advisor.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.

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©2003 Wayne Cheveldayoff